Rise and Shine - The Verismo ts Here

Somnath is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

“A perfect Starbucks Latte at home. And at the push of a button,” promises Starbucks’ website.

Starting of a brand new day

The Verismo from Starbucks (NASDAQ: SBUX) is the first single cup machine that can make brewed coffee, espressos, and lattes with fresh milk. The Verismo retails for $199, although the single-serving coffee market has long been described as a razor/razor blade type model, wherein companies sell machines for low profits and then rake in the big bucks on refills. The Times reports that the market for single-cup machines and single-serving pods exceeded $8 billion in 2011.

“It’s really exceeded our expectations,” Alisa Martinez, a spokeswoman for Seattle-based Starbucks, said in an interview. “Some of the machines are on back order and they should be in today. We have a good understanding of the demand that we’re going to be seeing,” she said. The Verismo will be available in about 65% of Starbucks’ U.S. cafes beginning Oct. 16.

Starbucks has been fiercely attempting to diversify its revenue stream, in an attempt to move away from simple coffee. A number of previous experiments designed to accomplish this goal jump to mind: Via instant coffee, Evolution Fresh juices, new food offerings, wine/beer sales, etc. Although it remains to be seen whether consumers will latch on to the Verismo machine, Jeff Hansberry, president for channel development and emerging brands at Starbucks, has stated that single-cup coffee sales grew by 143% last year.

Green Mountain Coffee Roasters (NASDAQ: GMCR) has dominated massive single-cup market in recent years, emerging as the countertop-coffee king thanks to 37 patents that protect the omnipresent K-cup coffee pods. Two of those main patents, however, expired last week, leaving GMCR wide open for competition. Already word on the street is that Starbucks may spell the death of Green Mountain Coffee Roasters.

The recent expiration of two patents governing the design of the K-Cups has ushered in a number of unlicensed competitors. Analysts say that these new rivals could put pressure on prices overall and, as a result, cut into Green Mountain's profit margins. In a bid to appeal to more consumers, Green Mountain Coffee Roasters will sell a less expensive model of its new Keurig Vue coffee brewer. The company said on Thursday it is launching a new Keurig Vue model with a suggested retail price of $209.99. Its original Vue model has a price tag of $229.99, recently lowered from $249.99.

Despite Starbucks CEO Howard Schultz claiming that the relationship between his company and Green Mountain will remain intact, many investors feel otherwise. Green Mountain shares plummeted in March when the Starbucks machine was initially announced, and have lost 44.57% of their value this year. The company makes coffee pods for Starbucks and Dunkin Donuts (NASDAQ: DNKN), but now that the patent has expired it seems likely that the two coffee outlets will find a way to become independent.

Consistent branding pays

In its recent results, Starbucks posted a 13% jump in quarterly revenues. The EPS growth stood at 19% and the company’s operating margin grew by 1.2%. The American division witnessed a 7% growth, while the Chinese division saw a 12% growth. The high costs of coffee beans this year added a burden of $38 million, which kept the bottom line under pressure. We believe that since the company deals with fulfilling the cravings of millions, increasing the prices of its offerings won’t hurt its top line.

Schultz has drawn a distinction between the type of consumer who would buy the $199 latte-producing Verismo, and those who only want a brewed coffee machine. It’s possible that the Keurig will remain the morning companion of choice for brewed coffee drinkers, but as some are quick to note, Starbucks looks unstoppable. The company makes up 29% of the United States coffee market, has $2.5 billion in cash, boasted a profit margin of 56% in 2011.  And don’t forget, the company has a market cap of $38 billion.  Green Mountain is about a tenth of that size.

Close competition

Dunkin Donuts, a close competitor of Starbucks, has only been public for one year, but has been serving coffee for over 60.  That doesn’t mean that the company is all that big—there are only 2,600 Dunkin’s worldwide, and what Dunkin’ sold in the last five years is less than what Starbucks sold last quarter.  This means that Dunk probably isn’t Starbucks’ greatest threat.  Dunkin’s debt/equity ratio is 1.95, while the expected EPS growth in 2013 is 19.84%. The expected ROI is 2.19% and net profit margin is 9.61%. 

Dunkin’ Brands is inexplicably priced. It trades at higher price-to-earnings and price-to-sales multiples than Starbucks or Caribou Coffee even though it faces similar global challenges, firm-specific legal issues. Worse yet, analysts forecast lower growth for Dunkin’ brands. For these reasons, Dunkin’ may be an attractive short candidate for portfolio hedging.

The undisputed leader

Starbucks has a relatively stable topline and an attractive bottomline, which is increasing steadily. The management at Starbucks has been very aggressive in its approach regarding the expansion plans of the company. To add to the growth story, the company was also involved in a series of acquisitions along with the introduction of its new vending machine named Verismo. The numbers look good and the company is well diversified both business wise and geographically. With 30% ROE and 18% ROA the Starbucks is definitely a strong buy.

SomnathGuha has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters, short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters, and short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Green Mountain Coffee Roasters and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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